ECB keeps policy unchanged as expected despite record inflation
The European Central Bank kept policy unchanged as expected today, curbing stimulus over the coming months but maintaining plenty of support for the economy even after inflation unexpectedly hit a fresh record high.
After the ECB extended support measures only in December, policy change was not expected to be on the agenda.
But stubbornly high inflation – which rose to 5.1% last month in the 19-country euro zone – is complicating life for the bank.
Making only the smallest change to its statement, the ECB removed a clause stipulating that its next policy move could be in “either direction”.
“The Governing Council stands ready to adjust all of its instruments, as appropriate, to ensure that inflation stabilises at its 2% target over the medium term,” the ECB said
“Flexibility will remain an element of monetary policy whenever threats to monetary policy transmission jeopardise the attainment of price stability,” it added.
The ECB has long argued that inflation will soon abate without its intervention and actually fall below its 2% target by the end of the year, so that withdrawing support now would be counterproductive.
But a growing number of policymakers question this narrative, especially since the ECB has persistently underestimated the current spike, forcing it to repeatedly revise its forecasts.
Markets already doubt the ECB projections and are pricing in 28 basis points of rate hikes this year, despite the bank’s insistence that any move in 2022 is very unlikely.
The issue is that inflation is forecast to dip below its 2% objective in 2023 and 2024, so that even a small increase in the inflation path could put price growth right on target, reducing the need for stimulus.
In her news conference, Lagarde could offer a nod to inflation risks while emphasising that the base case is still for price growth to slow sharply late in the year, as wage growth in the euro zone remains muted and one-off factors fade.
She is also almost certain to repeat that any rate move this year is very unlikely, even as global peers like the US Federal Reserve and the Bank of England tighten policy.
ECB watchers are nevertheless moving forward their rate hike predictions, with many now expecting a first move in early 2023 rather than late next year.
With today’s decision, the ECB’s deposit rate remains at a record low -0.5% and the bank on course to phase out its €1.85 trillion pandemic emergency bond buying scheme by the end of March.
The ECB’s main refinancing operations remains at zero while its marginal lending facility stays at 0.25%.
European Central Bank President Christine Lagarde acknowledged today that euro zone inflation was running hotter than expected and with risks tilted to the upside, but continued to forecast it would ease through this year.
Speaking after the ECB kept its policy unchanged, Christine Lagarde told a news conference that policymakers would not rush into new moves, but also chose not to repeat her past comment that a rate hike this year was very unlikely.
“Inflation is likely to remain elevated for longer than previously expected but to decline in the course of this year. Compared with our expectations in December, risks to the inflation outlook are tilted to the upside, particularly in the near term,” she said.
“The situation has indeed changed,” she added.
In response to questioning, President Lagarde said the ECB had never, in recent times, described the outlook for inflation in this way and that they were being very “explicit” in pointing to the risk that inflation might be higher over the course of this year and higher at the end of the year than had been previously thought.
President Lagarde also twice, when asked in the press conference, pointedly did not repeat a phrase used by her in recent months that a rate hike this year would be “highly unlikely”
The ECB will produce a revised economic outlook and forecasts for inflation at its next Governing Council meeting in March.
It is also expected to make clear its intentions around its Asset Purchase Programme, which buys up debt on the market. It confirmed that its Pandemic Emergency Purchase Programme will end next month.
President Lagarde repeated that bond buying programmes would be ended before considering any move to raise interest rates and that the ECB would be “very faithful to our sequence”.
The ECB’s opening statement said that inflation had surprised on the upside last month and was likely to remain elevated for longer than “previously expected, but to decline in the course of this year.”
The rise in inflation was driven by higher energy and food prices.
Ms Lagarde told reporters that while there was “unanimous concern” among ECB Governing Council members about inflation, they were also determined not to rush to any conclusions until more information was available.
“We will continue to observe the sequence we have agreed and we will be gradual in any determination we make,” she said.
While global peers such as the US Federal Reserve and the Bank of England tighten policy, the ECB earlier kept policy unchanged, staying on track to provide copious stimulus.
Lagarde said January’s higher-than-expected inflation rate of 5.1% was predominantly down to the direct and indirect impact of a surge in energy costs, with higher food prices also weighing due to higher transport and fertiliser costs.
While she said the impact of the Covid-19 pandemic was becoming less severe with each wave, she stressed that national virus containment measures could still dampen activity.
Without referring explicitly to tensions between Russia and the West over Ukraine, she said that “geopolitical clouds were hanging over Europe” which could also hit growth prospects.
The ECB has long argued that inflation will soon abate without its intervention and actually fall below its 2% target by year-end, so that withdrawing support now would be counterproductive.
But financial investors and a number of policymakers have started to question this narrative, especially since the ECB has persistently underestimated the current spike, forcing it to repeatedly revise its forecasts.
Markets already doubt the ECB projections and are pricing in 28 basis points of rate hikes this year, with the first move seen in July, despite the bank’s insistence that any move in 2022 is very unlikely.
The issue is that inflation is forecast to hold just below its 2% objective in 2023 and 2024, so even a small increase in the inflation path could put price growth right on target, reducing the need for stimulus.
Additional reporting by Robert Shortt